John E. Richardson, Jr.
CPA - CFP
Certified Financial Planner
Senior Financial Advisor
for Strongtower Financial
Variable annuities are probably one of the most maligned investment vehicles in the market today. Many negative articles have been written about them in recent years. The truth about variable annuities is that they are neither good nor bad. The key to variable annuities lies in suitability and diversification. By definition, a variable annuity is an insurance product. It contains investments called sub-accounts that are very similar to mutual funds. As these sub-accounts fluctuate with the market, so does the value of the variable annuity. One big difference between investing in mutual funds and investing in variable annuities is the insurance company may offer guarantees as to the variable annuity's performance.
Here is how one particular variable annuity's guarantee works. The insurance company will guarantee during the first 10 years of the contract that the withdrawal benefit basis of the contract will grow at least 7% per year compounded. This guarantee applies regardless of how the underlying sub-accounts perform. However, if the sub-accounts perform better than 7%, you not only get the higher performance, but that performance is locked in on a daily basis. For example, during the first three years of a $100,000 contract, an account earned 10% each year. In year four, a bear market began. The account lost 33% in year four. While the sub-accounts at the end of year four would be back to what the investor originally invested, the guaranteed withdrawal basis continued to grow at a rate of 7% from the highest daily value the sub-accounts ever achieved. So, at the end of year four, that basis would be over $142,000! Not a bad strategy as part of your portfolio. At that point, if you began to take withdrawals from the contract, you would be guaranteed to receive between 5% and 8% of the $142,000 per year for the rest of your and your spouse's life. That is all without annuitization of the contract. So, at the end of your joint lives, your heirs would inherit the remaining balance of the contract.
However, these guarantees come at a cost. These costs can be as much as 2.50% of the value of the account per year. While that is expensive, it is not nearly as expensive as watching your portfolio decline by 20% or more as we have seen in the recent bear market. In that case I would call the variable annuity a bargain! Think of it like buying an insurance policy for your investments. Variable annuities are not for everyone, but when correctly used as part of an overall retirement income strategy, they can serve a vital role.
John E. Richardson, Jr., CPA, CFP® is a Senior Financial Advisor with Strongtower Financial in Escondido. If you have any questions or comments, please contact him at (760) 705-3520 or by e-mail at firstname.lastname@example.org.